1. Field of the Invention
This invention relates to the field of compensation and employee benefits and, in particular, to methods for reducing fiduciary liability for employers and plan sponsors when permitting plan participants to choose benefit options or self-direct plan investments.
2. Background of the Invention
Increasingly compensation and employee benefit plans have permitted employees to make choices and selections as to the form that their compensation and employee benefit coverage takes. This is true of health and welfare plans where such programs as flexible benefit plans under Section 125 of the Internal Revenue Code are permitted, and in the retirement planning area where employees select their own investments under self-directed defined contribution plans. In the retirement savings area, many employers have moved away from defined benefit plans to defined contribution plans. Within these defined contribution plans, many of which involve Section 401(k), Section 403(b) or Section 457(b) arrangements, employers permit employees to select their own plan investments. At the same time, the Employee Retirement Income Security Act (ERISA) of 1974 imposes fiduciary responsibilities on the employer sponsoring the plan to assure the suitability of the various investment options at inception and to continue to monitor these investment options for their suitability on an ongoing basis. (For plans not specifically subject to ERISA-imposed fiduciary liability, many of these plans will follow the precepts and legal principles established by ERISA plans as models of “best practices.” This would be true of governmental plans and church plans that are exempt from ERISA-imposed fiduciary requirements. Accordingly, the invention described in this patent application would also have relevance to these non-ERISA plans as a “best practice” or under general trust law for assuring the best interests of plan participants even if a plan is not subject to ERISA under the law.)
In recent years, the extent to which an employer must exercise “due diligence” with monitoring investment suitability has been a subject of judicial review. Fiduciaries are required to act prudently in selecting and monitoring plan investments. With the transformation of the private pension system to one where employees make decisions regarding their own plan investments, other issues such as what an employer can do to facilitate investment education and who is able to provide investment advice have been undergoing major change.
The extent to which a plan sponsor must exercise “due diligence” regarding participant-directed plan investments was clarified in litigation tied to the massive bankruptcy of the Enron Corporation. The legal citation for this case is: Enron Corporation Securities, Derivative and ERISA Litigation, 284 F. Supp. 2d 511 (S. D. Tex. 2003). The decision by Judge Harmon, the presiding judge in the case, along with the “friend of the court” brief filed by the Department of Labor (DOL) clarified the fiduciary responsibilities of plan sponsors for participant-directed investments in an ERISA plan.
As statutorily determined under ERISA, the trustee or named fiduciaries of a plan are responsible for the investment of plan assets: [See ERISA ss405(c)] The trustee or named fiduciaries may appoint an investment manager (as defined in ERISA Section 3(38)), which will relieve the fiduciaries of responsibility for managing the investments, [see ERISA ss4 05(d)] but they must prudently select and monitor the manager. Section 404(c) of ERISA provides a procedure under which fiduciaries may be relieved of liability for losses resulting from a participant's exercise of control over his or her own account. To obtain 404(c) relief, the plan must comply with roughly 20 requirements found in the DOL regulation.
In her decision, Judge Harmon stated: “If a plan does not qualify as a 404(c) [plan], the fiduciaries retain liability for all investment decisions made, including decisions by the Plan participants.” [emphasis added] This decision by Judge Harmon was aligned with the “friend of the court” brief filed by the DOL in the Enron case which stated:                The only circumstance in which ERISA relieves the fiduciary of responsibility for a participant-directed investment is when the plan qualifies as a 404(c) plan under ERISA ss404(c) . . . a fiduciary is not liable for losses to the plan resulting from the participant's selection of investments in his own account, provided that the participant exercised control over the investment and the plan met the detailed requirements of a Department of Labor regulation.Below is cited commentary by an expert on fiduciary liability explaining the implications of this landmark judicial decision on fiduciary liability issues for employee benefit plan sponsors:        What the Enron decision emphasizes is these responsibilities apply even to investment decisions made by the participants with respect to their own accounts—unless the plan complies with the requirements of ERISA Section 404(c). This is a powerful statement, because, for participant-directed plans, it places the responsibility for the prudence of participant investment decisions on the fiduciaries. Why? Because, in our experience, few plans actually comply with the requirements for 404(c) protection. It is commonly understood that fiduciaries remain responsible for selecting the investment options in participant-directed plans. Many fiduciaries, and most advisors, also know that fiduciaries can only be relieved of responsibility for the investment of participant accounts if the participants actually exercise investment control. What has not been commonly understood is that the fiduciaries can only be relieved of liability for participant investment decisions if the plan meets the detailed requirements of the DOL's 404(c) regulations. [DOL Reg.ss2550 404(c)-1; . . . ]        Put another way, the fiduciaries remain responsible for the prudence of the participant investment decisions even though the participants make the decisions. Merely allowing participants to decide how to invest their own accounts is not enough; the fiduciaries must take steps to ensure that the plan provides a broad range of investment options, provides the participants with the opportunity to exercise control over their accounts, and provides the participants with information sufficient to enable them to make informed investment decisions. And that must be done in a way that satisfies the 20 or so specific requirements in the regulation. If these requirements are not met, the fiduciaries are charged with the responsibility for the participants' decisions. Needless to say, this strongly reinforces the importance of complying with the 404(c) requirements—and the need to provide an investment structure that supports well-invested participant accounts (such as age-based life cycle or risk-based life style funds, managed accounts, or asset allocation models). (Reish, pp. 3-4, Lessons from the Enron Litigation)        
Until the legal clarifications were made in the previously stated court case, the extent to which a plan sponsor or fiduciary possesses fiduciary liability for participant-directed plan choices was not fully understood and appreciated by most plan sponsors. Now as plan sponsors become aware of their potential liability exposure in these areas, they will look to find business methods that decrease or avoid such liability. As recommended by the expert (Reish) on fiduciary liability, several approaches are available to support the goal of an investment structure that supports well-invested participant accounts. One such approach suggested above is using an asset allocation model. Here an individual would determine an asset allocation approach that incurs the amount of risk he or she is willing to accept consistent with the risks and returns that various asset classes have exhibited historically.
Another approach would entail use of a risk-based life style fund. A risk based life style fund is a single fund or fund of funds whose asset allocation weightings are determined by how much risk an individual seeks to incur. One might select from a “conservative,” “moderate,” or “aggressive” allocation. Typically the “aggressive” allocation would have the largest weighting in equities. These funds free investors from having to rebalance their portfolios over time if they have selected a particular amount of risk they seek to incur. The portfolio manager would automatically rebalance the portfolio to preserve the asset allocation consistent with the risk preference initially selected.
Another approach suggested above is an age-based lifestyle fund. These types of funds are also called target date retirement funds. “Target date retirement funds are the most important 401(k) product development initiative to come along in the last ten years, and I give credit to Fidelity (Investments) for pioneering this concept with the introduction of the Freedom Funds targets in October of 1996 . . . Target date funds are no more than any other asset allocation or a life cycle fund with two rather uncomplicated twists: (a) the fund has wisely been ‘labeled’ to correspond with an anticipated year of retirement, and (b) rather than keeping the allocation static, the fund's equity exposure gradually slides down a ‘glide path’ over time.” (Malone, p.1 Mar. 23, 2006)
Yet another approach would be to use a managed account. With a managed account, an investment manager would look to manage investments consistent with pre-determined risk levels that are made known to investors. Some investment professionals have actually suggested use of a questionnaire to determine risk preference and then manage multiple accounts that would tailor investments in those specific accounts to the identified risk preferences of investors. This approach would avoid participants directing their own investments and leave the investing responsibilities with the investment manager selected by the plan sponsor. (Chang, Simon, and Allen, 2005)
Although many of the aforementioned investment structures have significant advantages, they also have certain disadvantages. A primary and significant disadvantage common to all of the aforementioned investment structures is that they curtail the ability of the individual participant to select investments that he or she expects will provide the best investment return given his or her individual risk profile. For the knowledgeable investor, the ability to self-direct one's plan investments holds significant appeal. All of these other suggested investment structures serve to limit fiduciary liability exposure for the plan sponsor, but in doing so, restrict the freedom of the individual plan participant to customize his or her benefit plan.
Following the Enron decision, another court case was decided involving a plan sponsor that did not qualify for 404(c) protection. In this decision, (Jenkins v. Yager & Mid America Motorworks, Inc., No. 04-4258 7th Circuit, Apr. 14, 2006), it was held that ERISA section 404(c) is only a safe harbor and the actions of the plan trustee, when delegating decision-making authority to plan participants, must be evaluated to see if they violate a trustee's fiduciary duty. In Jenkins v. Yager & Mid America Motorworks, Inc., the Court found that “Mr. Yager provided his employees with the necessary information to enable them to direct their investments in the 401(k) Plan, including by holding yearly meetings with a financial advisor to discuss investments in the 401(k) Plan.” (White & Case, p. 3) The significance of the Yager decision is that it allows plan sponsors to prove they did not violate a trustee's fiduciary duty if they take proactive steps that are beneficial to participant decision-making. The suggested invention provides a means for a plan sponsor or fiduciary to limit fiduciary liability exposure while preserving the ability of the individual participant to customize his or her benefit plan.
Following passage of the Pension Protection Act of 2006 (PPA), enacted into law in August of 2006, the Department of Labor (DOL) issued guidance concerning default investments in participant directed individual account plans. The following background and guidance was provided:                “With the enactment of the PPA, section 404(c) of ERISA was amended to provide relief afforded by section 404(c)(1) to fiduciaries that invest participant assets in certain types of default investment alternatives in the absence of participant investment direction. Specifically, section 624(a) of the PPA added a new section 404(c)(5) to ERISA. Section 404(c)(5)(A) of ERISA provides that, for purposes of section 404(c)(1) of ERISA, a participant in an individual account plan shall be treated as exercising control over the assets in the account with respect to the amount of contributions and earnings which, in the absence of an investment election by the participant, are invested by the plan in accordance with regulations prescribed by the Secretary of Labor. Section 624(a) of the Pension Protection Act directed that such regulations provide guidance on the appropriateness of designating default investments that include a mix of asset classes consistent with capital preservation or long-term capital appreciation, or a blend of both. In the Department's view, this statutory language provides the stated relief to fiduciaries of any participant directed individual account plan that complies with its terms and with those of the Department's regulation under section 404(c)(5) of ERISA. The relief afforded by section 404(c)(5), therefore, is not contingent on a plan being an ‘ERISA 404(c) plan’ or otherwise meeting the requirements of the Department's regulations at ss 2550.404c-1. The amendments made by section 624 of the Pension Protection Act apply to plan years beginning after Dec. 31, 2006.        On Sep. 27, 2006, the Department, exercising its authority under section 505 of ERISA and consistent with section 624 of the Pension Protection Act, published a notice of proposed rulemaking in the Federal Register (71 FR 56806) that, upon adoption, would implement the provisions of ERISA section 404(c)(5).” (Federal Register (29 CFR Part 2550, p. 60452)        
The final rules were published in the Federal Register on Oct. 24, 2007 and these final rules had an effective date of Dec. 24, 2007. It is not entirely certain as to the effect of these relatively recently issued final rules on default investments on the implementation and use of the invention in this patent application. It is believed by the inventor that the use of this invention may be integrated within the enrollment and ongoing monitoring functions of a plan sponsor and be compatible with the rules of default investments.
The invention described in this patent application is particularly timely. On Feb. 20, 2008, the U.S. Supreme Court decided the case of LaRue v. DeWolff, Boberg & Associates, Inc., et al. This case clarified that individual participants in 401(k) and other retirement plans subject to ERISA have standing to sue plan fiduciaries to recover investment losses from their accounts. Previously when the Supreme Court decided the case of Massachusetts Mutual Life Insurance Co. v. Russell, it had held that individual participants could not bring an ERISA claim “to recover consequential damages,” but could only seek recovery by “the plan as an entity.” LaRue renders this prior holding irrelevant and permits a plan participant to pursue “damages” to the plan, even where measured solely by the injury to the plan participants' individual accounts (Thompson Hine, p.1). This important case was reported in The New York Times, Wall Street Journal, and the Washington Post newspapers on Feb. 21, 2008. (New York Times, pp. 1-2, Wall Street Journal, p. D1, and Washington Post, p. A01). This precedent-setting case is likely to result in increased litigation against plan sponsors by plan participants. Accordingly, the invention described in this patent application may assist plan sponsors in avoiding such litigation.
Employees who have been defaulted into investment choices may be particularly at risk should a market downturn occur, particularly if they are not well-informed investors. If invention is used as part of the enrollment process, it may protect less well-informed investors from fleeing beneficial long-term default investments prematurely when market corrections occur.
Currently there are various administrative record-keeping systems for processing benefits transactions. The patent to El-Kadi and Derienzo (U.S. Pat. No. 6,014,642) relates to a system for processing investment information, participant data and financial transactions with respect to employee benefits programs. Similarly, there are systems that provide for tracking and accounting of plan choices. The patent to Gilbert and Gupta (U.S. Pat. No. 6,041,313) relates generally to the field of computer-based retirement plan tracking and accounting with specific application to a modified 401(k) retirement plan. There have also been patents disclosing inventions that serve to allow investors to screen investments for appropriateness and that allow investors to assess their personal financial risk tolerance. The invention in a patent of Maggioncalda, Jones, Sharpe, Fine, and Tauber (U.S. Pat. No. 5,918,217) allows a user to explore how changes in risk tolerance, savings level and retirement age affect the probability of achieving one's financial goal. The patent of Davey (U.S. Pat. No. 6,859,788) discloses a method and system for the automated assessment of personal financial risk tolerance. The patent of Rebane (U.S. Pat. No. 6,078,904) discloses a system for optimally allocating investment funds of an investor in a portfolio having a plurality of investments.
The field of psychometrics has produced various types of testing instruments to ascertain measures of knowledge, aptitudes and proficiency. The patent of Penno (U.S. Pat. No. 6,705,870) discloses one such example. Some of these methods involve computer-implemented methods such as the method disclosed in the patent of Calhoun, Peterson and Merzenich (U.S. Pat. No. 6,565,359) which relates to a computer-implemented method and apparatus for remote cognitive and/or perceptual testing. Some of these methods and apparatuses provide a means of training as well as testing. The patent of Breznitz (U.S. Pat. No. 6,632,174) discloses a method for testing and/or training cognitive ability. Some of these testing and training instruments involve a simulation or case study. The invention in a patent of Gray and Coons (U.S. Pat. No. 6,944,596) makes use of an education business simulation. Some testing and training approaches make use of a technique known as adaptive testing. The invention in a patent of Moore, Cleveland, Vulfs, Carter, Cahill, and Heinz (U.S. Pat. No. 6,925,601) uses an adaptive testing tool. Once any type of cognitive or psychological test is administered, there usually is a method to record and retain performance. The patent of Poreh (U.S. Pat. No. 6,629,846) discloses a method for recording performance in psychological tests.
Although various types of psychometric testing instruments exist, they have not been used in conjunction with compensation and benefit plan enrollment systems to determine whether plan participants possess sufficient knowledge or capability to make certain plan choices. In accordance with my invention, using a measure of performance on a psychometric testing instrument to determine an array of either recommended plan selections or allowable choices under a plan protects plan participants and their beneficiaries. My inventive business method also allows plan sponsors to limit fiduciary liability and proactively fulfill their fiduciary responsibilities.